Reasons to Spend Your Tax Refund

The traditional advice about what to do with refunds is wrong.

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The vast majority of Americans overpay the IRS during the year, which means they are due for a tax refund right about now. Last year, 77 percent of taxpayers received a refund, with an average size of $3,000, according to the National Endowment for Financial Education. Of course, most financial experts say that you’re better off adjusting your withholding so you come out even on April 15, but a lot of people look forward to that “bonus.” And it turns out there are good reasons to continue receiving it, contrary to traditional advice.

First, refunds can provide an easy way to monitor where, exactly, your money is going. Otherwise, slightly higher paychecks throughout the year can just disappear along with the rest of your money.

[See 10 Smart Ways to Improve Your Budget.]

If you receive a refund, on the other hand, then you can think about exactly what you want to with it. Maybe you’ll use it to pay off debt, like 50 percent of taxpayers who receive refunds say they will do this year, according to the NEFE survey. (That echoes the recession-era behavior of two years ago, when an ING Direct survey found that most Americans saved their refunds or similarly used them to get debt off their backs. It might be a boring option, but it’s a smart one.)

Or you can use it to build your safety net. If you don’t yet have an emergency fund that could cover your immediate expenses should your income suddenly stop, then your refund can provide the seed money for it. Financial advisors typically recommend that you keep three to six months worth of expenses in the bank; NEFE offers a customized calculator that can help you come up with a goal for your own emergency fund.

But refunds can also be mad money—a way to justify an annual splurge. At least one financial expert, John Strelecky, urges taxpayers to do just that. He says that after you consider today’s average returns and inflation rates, people are better off using their refund money to enjoy life today, instead of saving it for some vague future purpose. “The point of earning money is to create memories, have amazing experiences, and do interesting things,” he says. “Don’t wait until age 65 to start spending your money to live a rewarding life.”

He makes a good point. As you weigh potential splurges, recent research suggests that spending on experiences, such as a family vacation, could bring more happiness than material purchases, such as a new washing machine.

[See 12 Money Mistakes Almost Everyone Makes.]

By comparing consumption data from the national Health and Retirement Study, Thomas DeLeire of the University of Wisconsin-Madison and Ariel Kalil of the University of Chicago found that spending money on leisure activities, which include vacations, movie theater tickets, and hobbies, improve happiness levels. (Happiness was measured by asking respondents to describe how they felt about their lives.) Expenditures on durable goods such as refrigerators, clothes, personal items, and housing, on the other hand, did not have an effect on happiness.

The apparent reason behind the leisure spending—happiness connection is even more intriguing than the finding itself: Spending on leisure activities appears to boost one’s level of social connectedness. That makes sense, since when you go on vacation, engage in a hobby such as tennis or bridge, or go out to the movies, you are almost always doing it with somebody else. So spending on leisure might boost your social connectedness, which in turn improves your happiness level.

The bottom line: Forget the old rules about coming out even on April 15. Keep getting your refund, and use it to create a memorable experience.

Kimberly Palmer (@alphaconsumer) is the author of the new book Generation Earn: The Young Professional's Guide to Spending, Investing, and Giving Back.